Where are all the tenants?

WHEN the tycoon James Goldsmith quipped: 'If you can see a bandwagon, it's already too late,' he may as well have been talking about London's buy-to-let market. A boom in buy-to-let mortgage sales in the South East continues, despite evidence that market conditions and the oversupply of homes for rent are leaving landlords with diminishing rents and empty flats.

Yet some advisers and lenders are still pushing the investment, even at the same time as letting agents are reporting difficulties in letting domestic properties.

With letting agents reporting rents up to 15% lower than at this time last year and properties empty for longer periods, homeowners are being forced to swallow average liabilities of more than £800 a month.

Interest rates are at their lowest for decades and rates for buy-to-let mortgages are attractive. According to the Council of Mortgage Lenders, 200,000 buy-to-let loans have been granted - a seven-fold increase since 1998. It estimates that three-quarters of these are in the South East.

Pundits, with the Monetary Policy Committee dropping the heaviest hint yet, say base interest rates are sure to rise, possibly by 1% in the next year. Each quarter% rise represents about a 5% increase in the average buy-to-let repayment.

'Oversupply is dragging the market down,' says Jeremy Leaf, housing spokesman for the Royal Institution of Chartered Surveyors (RICS). 'There is too much rental property chasing too few tenants, and not just in central London.'

Figures from the RICS quarterly survey, published on 28 May, will show that gross yields - rental income divided by the property value - fell in London for the sixth time in a row in the three months up to April 2002.

Most investors don't buy for income but to access the capital appreciation available from owning a second property. That's fine if the investment doesn't become a drain on your time and resources, but increasingly, buyers in London are suffering long periods with no rent.

'It's novice investors I'm concerned about,' says Paul Ilott, independent financial adviser at Bates Investments. 'Many people-have jumped in thinking London property is a low-risk, one-way ticket to substantial returns, but this isn't necessarily going to be the case.

'Those who may have overlooked the costs and hassle of void periods, falling rental income and the upkeep of property will be feeling the pinch,' he adds. 'A rise in interest rates could be the last straw.'

Statistics from the Association of Residential Letting Agents (ARLA) last month reveal a fall in rental return in the South East, from 7% to 6.5% in the past six months. Now, even estate agents in lettings strongholds such as Kensington and Notting Hill are having a tough time.

Robert Orr-Uwing, partner at property agent Knight Frank, and based in Sloane Avenue, says he has 50% to 75% more property available to let than at this time last year.

Allan Wegeland, director at Foxtons estate agents, says: 'A year ago, there were three properties to each applicant - now that's nearer eight properties.'

Malcolm Harrison, spokesman at Arla, adds: 'The main problem is investors piling into the same type of property. There is a glut of two-bedroom flats, so there are pockets of saturation.'

Agents in Clapham, where typical rents are 10 to 15% lower, say it takes more time and more tenants to fill a vacant flat.

'Landlords here are having to accept that they will get less money than they did even six months ago - before, you were having to show only two or three candidates per property, now it is eight or 10,' said one.

The average void term in London has grown to six weeks, compared to the national average of 36 days, according to Arla agents. But even when you find a tenant, rental income is static at best, with many letting agents reporting falling rent. If interest rates rise, landlords not locked into fixed-rate loans or who have over-stretched on borrowing could be in trouble.

With the average London house price topping £194,000, a typical buy-to-let investor would need to borrow about £155,000, assuming a 20% deposit. Most lenders will not accept under 15% for buy-to-let.

David Hollingworth, independent broker at London & Country Mortgages, says monthly repayments on an interest-only buy-to-let mortgage at 5% would be £646. A 1% rise in interest rates makes that £775. With the average rent for a two-bedroom property in London being £1,187 a month and falling, rate rises will eat into rental profits.

Harrison adds: 'Property investors should be in it for the long-term. If they're not, they will probably now look to sell and cash in on any capital gains.

London's rental market is driven by corporate tenants, mainly from the US, so it has suffered due to the recession and 11 September. That gloom should lift a little now, though.'

Mark Harris, managing director of Savills Private Finance, says he will still recommend buy-to-let as an investment 'as long as people have done some homework and have money left to cover the voids.'

City regulator The Financial Services Authority warned investors of the risks of buy-to-let back in December.

John Tiner, managing director, said: 'House prices in the South East and London are the highest in relation to income, and loans have been at the highest income multiples in these areas. This exposes investors to the growing risk of market under-performance in these regions.'

Leaf, at the RICS, concludes: 'Investors who have come into the market late are sensing difficulties and getting out. We're seeing many cashing in on capital gains, and they can be significant in London. Over time, this should improve the state of the London market by reducing supply. It's a case now of how long investors can afford to wait.'

Prepare for a slowdown, not a collapse